A working paper exploring the idea that information equilibrium is a general principle for understanding economics. [Here] is an overview.

Thursday, January 15, 2015

Targeting NGDP is awesome

I'm always impressed with Nick Rowe's ability to quickly put together a model in a clear, concise way. However, and I might be wrong about this, this line does all the work in the model:

6. The central bank does whatever it needs to do to ensure its previously announced target will be hit.

I don't think the biased shocks are doing much in the model except allowing there to be a deviation from exactly hitting the inflation or NGDP targets. Essentially, you get a small bump above the inflation target or small bump below the NGDP target.

Here is a "simulation" (essentially assuming RGDP is fixed) of an inflation target and an NGDP target; the dashed line includes the asymmetric pricing -- the inflation data might come in above target during a shock or the NGDP data might come in below target.

The NGDP LT looks better, right? Well, if you take away the variance (but still allow asymmetric shocks), the reason becomes clearer:

NGDP level targeting is superior to inflation targeting because it effectively eliminates the NGDP (AD) fall of recessions ... but then -- as long as you're not into RBC theories -- a recession is a fall in AD!

You could rename the NGDP level target to be a "no recession target". How should the central bank conduct monetary policy? It should adopt a no recession target, of course! How do you do that? By doing whatever the central bank needs to do to do that, of course!

Well, that clears it up!

In my next post I will show how the ITM is an existence proof of a model in which both NGDP LT and IT eventually fail -- Nick Rowe's step #6 in the model becomes impossible without printing exponentially more and more money.